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Factor Investing Portfolios - Top Down Views from Amundi Research

The Quality factor: the right trade-off for 2018

To our minds, it is too early to take on a purely defensive profile, and it is too late to follow growth stocks, which are already very expensive. If we had to choose a single factor on which to focus, Quality would surely be the best trade-off, in our view. Below, we present our reasoning in two steps.

What is the best factor at this stage of the cycle?

Since the January 2016 oil price bottom-out and China’s efforts to prevent capital flight, the equity markets have rallied and resynchronised, as have economies, in a phase ii of the cycle.1 2 At the factor level, this phase is usually at first favourable to Momentum, and then to Quality before being joined by the High Dividend and Minimum Volatility factors, which are more defensive.

Let’s now take a snapshot of the current reality

The vertical axis of our map depicts market momentum; if the factor is positioned high, it outperforms the MSCI World (in US dollars) and vice versa if it is positioned low. The horizontal axis depicts earnings momentum. And the size of the circle refers to its relative valuation (the bigger it is, the most expensive it is). As the markets anticipate earnings, the natural direction is clockwise. A colour code highlights three types of factors: Value-Growth, Large-Mid-Small, and then the other styles.

Conclusion

The Growth style outperforms and is expensive, which feeds the bubble scenario. The ‘swinging doors’ risk is significant. Small caps, more cyclical and domestic, are still rather well positioned in Europe and Japan. Renewed hope regarding tax reform is again boosting them in the US, but low high-yield spreads and volatility, higher margins, a peak of M&A in the US, and the coming reduction of liquidity are likely to ultimately work against them in 2018. As it is less expensive than the Growth style and less indebted, Quality is the ideal candidate to take over from Momentum, which is still outperforming for good reasons, given that earnings are still faring well. And, additionally, the High Dividend and Minimum Volatility factors are lagging behind in both profitability and market behaviour, something that corroborates our interpretation that the global market is not yet positioned in phase iii.

Read more on Factor Investing Portfolios

1 See the Discussion Paper entitled “Short investment cycles: our roadmap”.2 Europe and Japan are in Phase ii. The United States has, in fact, been in phase iii since the end of tapering in mid-2014, but the resynchronisation of the cycle has generated a sort of phase ii within phase iii.